Asia’s Recent Past Catches Up With It; Federal reserve ‘tapering’ is merely exacerbating problems created by earlier failures to reform

September 5, 2013, 12:39 p.m. ET

Asia’s Recent Past Catches Up With It

Federal reserve ‘tapering’ is merely exacerbating problems created by earlier failures to reform.

FREDERIC NEUMANN

As investors cast around for someone to blame for recent market turmoil in Asia, it’s easy to point the finger at the U.S Federal Reserve. Hints that the Fed may taper its massive monetary easing, the thinking goes, has pushed up interest rates in America. That, in turn, is drawing capital away from emerging economies. There’s just one problem with this conventional wisdom: The current turmoil in emerging markets, above all Asia, has mostly local roots. It’s true that easy money provided a cushy ride since 2009. With rising interest rates in the United States, those days are now over. Still, the scale of the current sell-off, such as in India and Indonesia, suggests that something more profound is going on. After years of policy neglect, emerging Asia no longer offers the returns in growth and profits that investors seek. Only far-reaching reforms can pull the region out of its malaise.For all the headlines, it is important to keep things in perspective. Interest rates in the U.S. have climbed sharply this year. But they are only back to where they were two years ago. Moreover, dollar strength has not been uniform, with the greenback advancing only gently against the world’s major currencies as the sell-off in selected emerging markets intensified in recent weeks.

Rather, talk about tapering was merely the trigger for cashing out of economies whose fundamentals no longer look convincing. After peaking just before the global financial crisis, productivity growth steadily slowed. To sustain lofty rates of growth, more and more debt was required.

For a while, this was easy to finance, with interest rates tumbling to record lows. As the cost of borrowing now climbs, this inevitably inflicts pain.

However, the bigger issue, and the one that explains the scale of the latest financial market rout, is that too little of this borrowed capital went into efficient investment.

Cheap money, of course, is always seductive, inflating asset prices and fuelling speculation. But in Asia other factors skewed the allocation of capital as well. For example, state involvement, whether through state-owned enterprises directly or via ill-advised regulation, restricted deployment of capital in more productive ventures.

Take India. Despite its celebrated and aggressive private industrial conglomerates, the banking system, the nerve centre of any capitalist economy, remains mostly in public hands. Beyond this, restrictions, whether legal or judicial, curtailed investment.

For example, the country imports billions of dollars of coal, coke and other fuels each month, weighing on the trade deficit that so spooked markets of late. India sits atop energy reserves that are larger than in most other parts of Asia, yet those resources remain stuck in the ground due to an inability to enact economic reforms that would encourage extraction.

Indonesia, while basking in the reflection of newly erected glass condominiums in Jakarta, has so far failed to build a corresponding industrial base. As a result, consumer goods imports have swelled the trade deficit, leaving the country reliant on commodity exports and their wild swings in prices. Manufacturers complain about inadequate infrastructure and unreliable power supply, even as the country has gained in labor cost competitiveness, with wage gains elsewhere in the region outstripping those at home.

China, too, has seen productivity growth slow, reflecting reform fatigue for nearly a decade now. This has been largely because of a deteriorating performance among state-owned enterprises. By contrast, the return on assets by private firms, a short-hand measure of efficiency, has continued to climb in recent years and is now roughly double that of public companies.

Meanwhile, in Malaysia and Thailand the dominance of state-owned enterprises as well as costly subsidies on everything from fuel to rice curtail private investment and divert precious public funds from more efficient use.

What Asia now requires is obvious. To restore productivity growth and re-attract much-needed foreign capital, far-reaching reforms are needed. Pruning the pervasive reach of public enterprises would be one important step, along with less restrictive regulation for private firms. Outside of China, more funds need to be directed at public works instead of costly subsidies.

This is not a call for unbridled laissez-fair. Especially in emerging markets, the state retains a powerful and important role in steering progress. However, the efficiency of state intervention matters. This will need to be addressed if Asia is to attain its goal of sustained prosperity. Blaming the Fed’s taper talk for the current turmoil only diverts from the true cause of the region’s travails. Officials instead need to tackle what are mostly local challenges.

Mr. Neumann is co-head of Asia economics research at HSBC.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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